S corporation status is not automatic for a qualifying small business corporation. To elect to be taxed as an S corporation, a corporation must submit to the IRS a timely election that is consented to by afl shareholders as of the day the election is made. The election is made by filing a completed Form 2553, Election by a Small Business Corporation, accompanied by the required shareholder consents.

Shareholder consents

Regs. Sec. 1.1362-6(b)(2)(i) states that if stock of the electing corporation is held as community property, or if the income from the stock is community property, both the husband and the wife must consent to the S election. The statute providing that stock held by a husband and wife as community property is considered to be held by only one shareholder applies only in determining whether the 35-or-fewer shareholders requirement has been satisfied.

Delinquent consents

Since all shareholders as of the date of the election must consent, if only one spouse of a community property stock interest consents, the S election will be invalid (since unanimous shareholder consent was not obtained). There is a method for curing a defective election, however, when the sole problem is the lack of unanimous shareholder consent.

An extension of time for filing consents to an election may be allowed, provided the requirements set forth in Regs. Sec. 1. 1362-6(b)(3)(iii) are met. An election will not be considered invalid if the taxpayer can demonstrate to the satisfaction of the IRS that

--there was reasonable cause for the failure to file the shareholder consent(s);

--the request for the extension of time to file a consent is made within a reasonable time under the circumstances; and

--the government's interests will not be jeopardized by treating the election as valid.

Additionally, the delinquent consents must be filed within the extended period of time granted, and must include any new shareholders added before the extended consent filing date.

Planning for shareholder consents

The determination of whether or not stock is considered community property is made by reference to state law. Many times this determination is not a straightforward matter, such as when inherited stock is commingled in the community estate, where community property stock is transferred into a separate property state, etc. In those instances, competent legal counsel should determine whether the corporate stock is legally community or separate property. If doubt exists as to whether or not spousal consent is required for a valid election, such spousal consent should be provided with the S election. The election will not be invalidated or jeopardized if it turns out this spousal consent was unnecessary.

Obviously, every effort should be made to insure that the required shareholder consents are submitted with the originally filed corporate election. While the Treasury regulations do provide a mechanism for submitting delinquent shareholder consents, there is no guarantee that the IRS will administer such grace.

COPYRIGHT 1993 American Institute of CPA's
No portion of this article can be reproduced without the express written permission from the copyright holder.